The Pros and Cons of Creating a Family Limited Partnership

A Family Limited Partnership (FLP) is a type of partnership that can provide a wide range of benefits for families who are looking to transfer assets, protect their assets, and maintain control over their assets. An FLP is typically composed of two types of partners: general partners and limited partners. General partners are responsible for the management and control of the FLP, while limited partners have a passive role in the partnership and are only liable for the partnership’s debts to the extent of their capital contributions.

The purpose of creating an FLP is to allow families to transfer assets from one generation to another in a tax-efficient manner, while retaining control over those assets. This type of partnership can also provide asset protection and allow for easier management and control of family assets.

Before setting up an FLP, it is important for families to understand the pros and cons of this type of partnership. On one hand, FLPs can provide estate planning benefits, such as the ability to transfer assets and reduce estate taxes. On the other hand, FLPs can be complex to set up and manage, and they can also be expensive to establish and maintain.

In this blog, we will provide a comprehensive overview of the pros and cons of creating a Family Limited Partnership. This information will help families make an informed decision about whether this type of partnership is right for them, and what they need to consider before setting up an FLP.

Pros of Creating a Family Limited Partnership

Estate Planning

1. Transfer of Assets: One of the key benefits of creating an FLP is the ability to transfer assets from one generation to another in a tax-efficient manner. This is because FLPs are often structured in a way that allows for the transfer of limited partnership interests to the next generation, which can result in a lower tax liability for the transferor. This can be especially beneficial for families who want to pass on assets, such as real estate or investments, to their children or grandchildren.
2. Reduction of Estate Taxes: Another benefit of creating an FLP is the potential reduction of estate taxes. This is because the transfer of limited partnership interests to the next generation can be structured in a way that minimizes the value of the transferred assets for tax purposes. By reducing the value of the transferred assets, the transferor can lower the estate tax liability and ensure that more of their assets are passed on to their beneficiaries.

Asset Protection

1. Limitation of Liability: FLPs can provide a high level of protection for assets by limiting the liability of limited partners. This means that limited partners are only responsible for the partnership’s debts to the extent of their capital contributions. This is an important consideration for families who are looking to protect their assets from creditors or from potential lawsuits.
2. Protection of Assets from Creditors: Another benefit of FLPs is the protection of assets from creditors. This is because the assets held in the partnership are owned by the partnership and not by the individual partners. This can provide a layer of protection for the assets in case of bankruptcy or a lawsuit, as creditors cannot seize assets that are held in the partnership.

Control and Management

1. Retention of Control: FLPs allow families to retain control over their assets even after transferring ownership to the next generation. This is because general partners are responsible for the management and control of the FLP, and they have the power to make decisions about the partnership’s assets. This means that families can retain control over their assets and ensure that they are used in a manner that is consistent with their wishes.
2. Easy Management: FLPs can also be easy to manage compared to other types of ownership structures. This is because the partnership agreement lays out the responsibilities of each partner, and the general partners are responsible for the day-to-day management of the partnership’s assets. This can simplify the management process for families, as they do not have to navigate complex ownership structures or deal with disputes between partners.

Cons of Creating a Family Limited Partnership

Complexity and Expense

1. Complex to Set Up: Creating an FLP can be a complex process that requires the services of an experienced attorney and tax professional. This is because FLPs are a specialized type of partnership, and the legal and tax implications can be difficult to understand without professional help. Additionally, the partnership agreement must be carefully crafted to ensure that the FLP meets the specific needs of the family, which can further increase the complexity of the process.
2. Expensive to Establish: In addition to being complex to set up, creating an FLP can also be expensive. This is because of the costs associated with obtaining professional advice, preparing the partnership agreement, and registering the partnership with the appropriate authorities. These costs can add up quickly, and they can make an FLP a less attractive option for families who are looking to transfer assets in a cost-effective manner.

Limited Flexibility

1. Limited Ability to Modify: Once an FLP is established, the partnership agreement cannot be easily modified. This can be a disadvantage for families who are looking for a flexible ownership structure that can be adapted to changing circumstances.
2. Lack of Liquidity: Another disadvantage of FLPs is the lack of liquidity. This is because limited partners cannot easily sell their interests in the partnership, which can make it difficult for them to access their assets in the event of an emergency. Additionally, the limited partners’ interests in the partnership may not be readily marketable, which can further limit their ability to access their assets.

Potential for Conflict

1. Conflict Among Partners: FLPs can also lead to conflict among partners, particularly if the partnership agreement is not clear or if the partners have differing interests. This can be especially true when the partnership includes multiple generations of family members who may have different opinions about how the partnership should be managed and the assets should be used.
2. Conflicts with the IRS: Another potential issue with FLPs is conflicts with the Internal Revenue Service (IRS). The IRS may challenge the validity of an FLP if it determines that the partnership was created primarily for tax purposes, rather than for legitimate business purposes. This can result in significant tax consequences, including the recharacterization of the FLP as a general partnership, which would subject the partners to unlimited liability for the partnership’s debts.

Conclusion

In conclusion, Family Limited Partnerships (FLPs) can be a valuable tool for families looking to transfer wealth and assets from one generation to the next. By combining the benefits of a partnership with the tax advantages of a limited partnership, FLPs can provide a flexible and tax-efficient way to manage family assets.

However, it’s important for families to carefully consider both the pros and cons of creating an FLP before making a decision. The process of setting up an FLP can be complex and expensive, and the partnership agreement cannot be easily modified. Additionally, the limited partners in an FLP may have limited access to their assets and the potential for conflict among partners can also be a concern.

It’s essential to work with experienced professionals when setting up an FLP, including an attorney and tax professional, to ensure that the partnership agreement is well-crafted and meets the specific needs of the family. By considering the pros and cons and working with the right team, families can make informed decisions about whether an FLP is the right choice for them.